The author is a Forbes contributor. The opinions expressed are those of the writer.

Loading ...

Loading ...

This story appears in the {{article.article.magazine.pretty_date}} issue of {{article.article.magazine.pubName}}. Subscribe

By Marlene Givant Star

Business development companies (BDC) -- closed-end investment funds that make loans to small and mid-sized entities -- are muscling out other lenders including private equity groups in today’s frothy leveraged finance market. Part of the reason is that many BDCs are public so they can tap the strong stock market for capital. In addition, they are grabbing market share from banks, which are limited under Dodd-Frank as to the amount of leveraged loans they can make.

Other providers of mezzanine debt are having trouble competing with BDCs for deals. BDCs often provide unitranche financing, which combines senior and mezzanine debt into one blended rate, says Jim Hill, chairman of the private equity group of Benesch, Friedlander, Coplan & Aronoff. The “one-stop shop” proposition is “kind of compelling,” he says.

As the market is flooded with mezzanine debt, which falls in the middle of the capital structure between senior debt and equity, return expectations for investors in the asset class have come down.

At the same time, as transactions include more leverage – as much as seven times EBITDA-- with the same amount of equity, valuation multiples are climbing.

“Available leverage is so high that it discourages buyers. PEs and strategics can’t compete with people offering 6.5x leverage,” says Hill.

The last time business development companies were on a tear was in the 2005 to 2007 period, says Nadim Malik, CEO, Sutton Place Strategies LLC, a research firm. Then, as now, investors were hungry for yield and BDCs are known to pay high dividends. A lot of BDCs have been issuing stock in this market and doing secondary offerings, Malik says. “There’s a new BDC (offering) every month.”

Goldman Sachs formed a business development company, Liberty Harbor Capital, in May 2013. Meanwhile private equity firm TPG Capital registered its business development company (BDC) for an initial public offering in February and BNY/Mellon listed its Alcentra Capital BDC unit on the Nasdaq in May. Last month Alcentra provided $8 million in senior subordinated debt to refinance Southfield, Michigan-based GST AutoLeather.

Goldman Sachs Headquarters, New York City (Photo credit: Wikipedia)

“Goldman Sachs saw a great opportunity,” Malik says, but it joined a crowded field. There are 80 BDCs in the market, according to Sutton Place Strategies. Gladstone is one of the oldest.

The field is bound to get even more crowded as BDCs’ share of the mezzanine market is increasing. It rose to 44 percent in 2013 from 39 percent the prior year, according to Sutton Place. Of course, new entrants will need to act fast. BDCs will lose their luster once interest rates resume their climb.

Marlene Givant Star is global industrial sector head for Mergermarket and Dealreporter. She can be reached at marlene.star@mergermarket.com